Forex Trading Tips: Price Action is NOT Random

Price Action is NOT Random

The chart above courtesy of the ChartStore, recently appeared on Barry Ritholtz’s Big Picture blog and immediately caught my eye. What I find fascinating about it is how it completely contradicts the efficient-market-all-price-action-is-random school of thought. Those of us who trade every day of course know empirically that price action is not random at all. In fact all price action breaks into just two classifications – range and trend. What makes price action appear random to an untrained eye is the never ending flow of news that buffets prices much like a beach ball riding an ocean wave.

Reaction to that newsflow however is generally quite predictable. Good eco news will push prices up bad eco news will send them down. Before everyone hollers in protest of course this is not an ironclad rule but rather a guideline. Good eco news can be overshadowed by other considerations – as we are seeing now in the EUR/USD or it can have minimal impact if prices have already risen quite high and most of the news has been factored in. However, all things being equal a strong positive economic report will have a concomitant effect on the price action.

The reason why prices aren’t random is because they are set by human beings who are driven by just two emotions – fear and greed. Those waves of emotion, much like the waves of water follow a broadly repeatable pattern.

But back to the chart – why does it show that price action is not random? Take a look at September. If prices were truly random, if September was just another month on the calendar why would it generate consistently negative returns over more than 80 years of data? To be truly random that would mean that every 10th flip of a coin in a series of eighty 12-set flips would have to come up tails. It’s possible to occur if you have a highly unusual sample but very unlikely. It’s much more probable that the losses in September are caused by fear.

September after all comes at the end of the summer -- usually the happiest season for most men (and men with apologies to my partner and any members of the fairer sex who are reading this – make up the vast majority of traders and investors). In North America, summer is the season of baseball, beer, barbecue, beaches and bikinis. There are few red blooded American men who do not find pleasure in all those activities. So during the summer stock returns become engorged along with men’s bellies, but when September’s cruel call brings everyone backs to the office, the cold harsh light of reality often triggers a massive sell off as fear overwhelms greed.

Is that the reason for the September slide? Impossible to say for certain. But I think it sounds more plausible than just the mere randomness of fate. In fact the more I trade the market the more I am convinced that there is little about that it is random. Sometimes it appears to act in completely illogical ways, but that’s not because it is random. It’s because you haven’t figured out the dominant force driving price at that moment. Markets being human enterprises, sometimes that force can be pure manipulation. Fortunately we trade the biggest market of them all, one that even Goldie cannot control, and in the FX market price action is definitely not random.